1. The technique for incorporating Risk into capital budgeting that involves the use of numbers drawn randomly from probability distributions is called a:

scenario analysis.

sensitivity analysis.

Monte Carlo simulation.

probability simulation.

2. Which of the following is not a drawback of the simulation approach?

It can be very difficult to access and use a simulation program.

The probability distributions of the cash flows are subjective estimates.

There are no clear guidelines on how to interpret the results.

Cash flows in successive periods tend not to be independent.

3. Decision tree analysis:

may prompt management to reject a project with a positive NPV (point estimate).

does not apply to IRR analysis.

provides a relatively quick and easy way to get a rough idea of the probability distribution of NPV outcomes in a capital budgeting project.

"provides a relatively quick and easy way to get a rough idea of the probability distribution of NPV outcomes in a capital budgeting project" and "may prompt management to reject a project with a positive NPV (point estimate)" both are correct.

4. Richmond Graphics is a small company contemplating a project with a $5M initial investment. A traditional capital budgeting analysis shows the project to have an NPV of $3.3M. However, a simple decision tree analysis reveals that the project has a 90% probability of an NPV of $4.0M and a 10 % chance of a ($3.0M) loss NPV. Management should probably:

reject the project because it entails a fairly good chance of a loss that could ruin a small company coupled with a likely gain that isn't very large.

reject the project because it has some risk.

accept the project even though there is some risk because the overwhelming likelihood is that the outcome will be favorable.

accept the project because its traditional NPV is positive.

5. A company's cost of capital is the most appropriate discount rate to use when analyzing which type of project(s)?

Expansion projects

New venture projects

Replacement and expansion projects

Replacement projects

Expansion and new venture projects